EXIT STRATEGIES: Leveraging the valuation

Building growth potential

If growth makes a difference in the valuation, then significant growth would have a dramatic impact on valuation. However, few businesses can maintain high rates of growth over a long period of time. It is estimated that only four firms in 1,000 can manage growth rates over 20% for more than four years in succession.

These firms, called ‘gazelles’, are, therefore, the exception. Projecting growth rates in excess of 10 to 15% over any extended period is going to require some very convincing supporting evidence.

Short-term increases in growth or step changes in growth are certainly feasible. Whether this is achieved through innovations within the firm, a series of acquisitions or the introduction of new lines of business, such changes are common and easy to demonstrate. This can be easily validated if the change has already taken place and the results are already contributing to actual profits.

Projected increases in growth are often dismissed by buyers as the owners don’t have a track record to show the growth can be achieved or sustained. Buyers require a lot of convincing before they will accept growth potential as part of a valuation formula, however, it is not impossible and I will show in a later chapter how this can be done. In the meantime, it is clear that such changes can have a dramatic effect on the valuation.

Impact of Different Step Changes in Profits on Net Present Value

Again, you can see the dramatic impact of adding a growth component to the profit of the business. Such step changes are certainly possible given some planning and, perhaps, some investment on the part of the current owner. Most entrepreneurs know how and where their business could be developed, either given additional resources or simply more time and energy from the owner.

You can see the impact of a step change of about 70% (by year three) in the first example added between 100% to 200% to the value of the business. When a larger step change was combined with a 10% cumulative increase in profits, the valuation dramatically jumped 250% to 350%. In a situation where there was a step change, a continuing increase in profits and a significant drop in risk (discount rate movement from 50% to 15%) the increase in value was over EIGHT times.

While achieving actual or step change in growth might be beyond the capabilities and resources of the current owner, it is possible to put in the groundwork for growth, what I call the ‘Platform for Growth’. That is, what can you do now to provide future profits in the business even if the actual results have not yet materialised? This is profit potential. Buyers are very hesitant to accept such projections but that is not to say they won’t, they just need to be convinced.

Highly probable future profits based on projects which the firm undertakes before the sale which can clearly demonstrate profit potential can often be counted in with existing profit trends.

Tom McKaskill is a successful global serial entrepreneur, educator and author who is a world acknowledged authority on exit strategies and the former Richard Pratt Professor of Entrepreneurship, Australian Graduate School of Entrepreneurship, Swinburne University of Technology, Melbourne, Australia. A series of free eBooks for entrepreneurs and angel and VC investors can be found at his site here.